# Neelkanth Mishra on the Inflation Spectrometer

There’s learning macroeconomic theory, and there’s applying what you know to the world around you. In an excellent column, which we shall parse together, Neelkanth Mishra teaches us how to use basic micro and macroeconomics to make sense of the world around us.

He begins with an analogy of the spectrometer, a device used to ‘disentangle’ waves. Having explained what a spectrometer is, and what it might be used for, he then goes on to say that you might be able to do something similar with economic phenomena, and asks if you could use an idea analogous to the spectrometer to disentangle the phenomena that are causing inflation.

Let’s dig in.

In theory, inflation is a macroeconomic phenomenon, and analysing it by category is unwise, as prices shift both supply and demand between categories — sometimes global and local factors mix as well. For example, higher oilseed prices could shift acreage from pulses in the upcoming Indian kharif crop, pushing up prices of pulses even though the initial supply disruption was in Ukrainian sunflower oil.

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It’s one thing to learn about supply and demand. It is quite another to learn about partial equilibrium. But it is a whole other thing (and the point of the entire exercise) to be able to apply these ideas to what we see around us. Can higher oilseed prices cause an increase in the price of pulses? And even if you were to tentatively say ‘yes’, the real challenge would be the follow-up question: through what channels, and why?

He identifies two clear strands of driving factors that are responsible for inflation today, beginning with a larger than necessary stimulus applied in America during Covid-19. As an interesting aside, he says that this ended up pushing retails sales ten standard deviations above normal.

If you are a student reading this, take the time to pause over here and reflect on this statistic. Ten standard deviations above normal? That sounds like a lot! But you should also ask yourself the following:

1. What does above normal mean? How is it defined? Average annual sales over the last decade? Or is it monthly sales over the last five years? Or some other construct?
2. The standard deviation only makes sense given our understanding of the first bullet point. What period has been used? How often have ten standard deviation events taken place in the last, say, one hundred years (assuming we have data going back that far, of course)?
3. None of this, to be clear, is me doubting what Neelkanth Mishra has said. The point I am making is that you, as a student of economics, should try and run some Google searches to find out where that number comes from, or best of all, try and run the analysis yourself. Search for retail sales on Fred St Louis, and knock yourself out with a spreadsheet. As they say, get your hands dirty!
4. Read the rest of the paragraph to get a sense of how to think through macroeconomic issues and understand them better.

The downward lash of this bullwhip is now starting, which can push apparent demand well below real demand. US federal fiscal deficit as a share of gross domestic product or GDP in the last three months is the lowest since June 2019. As services restart, a goods-to-services switch in consumption is underway; shipping bottlenecks have eased (though not fully); global industrial production got back above trend in February (though recent lockdowns in China hurt); and there is evidence of excessive inventory in many supply chains. Prices of TV panels and memory chips are falling, and the year-on-year price increases in metals are now much below those seen in April. Prices may not go back to the pre-Covid levels (meaning deflation from here), but the inflationary impulse does seem to be behind us.

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1. Learn about the bullwhip effect.
2. Play around with this chart to verify for yourself the fiscal deficit point. (If anybody reading this works, or can work with the RBI, please push for the DBIE website to be more like, and indeed better than, the Fred St Louis website. Thank you.)
3. Run some searches for memory chip prices (add words like “trend”, 2022, H2 2022 and use Google’s search filters to narrow down the search results).
4. Reflect on whether you agree about the inflationary impulse from the USA’s fiscal stimulus now being behind us. Say you had to disagree with his point: what would you choose to drag up as points that negate his hypothesis?

The second global impulse, the start of the Russia-Ukraine conflict, may be harder to adjust to, with demand and supply adjustments likely to take many quarters. The conflict and the associated sanctions have reduced the global supply of food and energy. Given that global GDP growth and the use of dense energy are intimately linked, fiscal and monetary measures can only redistribute what remains between countries; they cannot offset the shortages. Nearly every major economy has announced energy subsidies — while this is understandable, given the domestic political compulsions as well as the need to sustain growth, they will only prolong the period of higher energy prices. This can be seen as countries competing for the remaining supplies of energy, pushing up prices until the weak hands (countries) give up. Higher prices have also not triggered investments in new supplies yet, as suppliers lack certainty on how long the shortages may persist. These trends could keep prices higher for longer than currently anticipated.

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1. Understand the point about fiscal and monetary stimuli being of limited use in a global context.
2. Understand the unseen effect of domestic subsidies on global oil prices
3. Trust me on this – there’s many, many, many pages of reports, news articles and blog posts that have been read for that one seemingly simple fragment of a sentence: “as suppliers lack certainty on how long the shortages may persist”. Learn, for your own sake, the art of reading a lot in order to be able to give a concise summary.

Moving to local drivers of inflation: Inflation occurs when a stimulus pushes aggregate demand above the economy’s capacity to meet it. Even though state governments’ deficits are much lower than budgeted, the total government deficit in India is higher than in pre-Covid times. The recent fiscal steps to prevent a rise in fertiliser and fuel prices, while prudent and to some extent necessary, may serve only to spread inflation over a longer period. The rise in India’s current account deficit (CAD), with May balance-of-payments (BoP) deficit run-rate at nearly 2 per cent of GDP, also suggests domestic demand, at least in its current mix, is unsustainable.

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If I was conducting an interview for a student who was aspiring to join the corporate world as an economist, I would have liked to have shown the candidate this paragraph, given them a laptop with an internet connection, and told them that they have thirty minutes to find the answers to the following questions:

1. Find out for me the original source from where we can find out that state government’s deficits are much lower than budgeted
2. Find out for me the original source for India’s CAD and B-O-P deficits.
3. Answer for me, with data to back up your answer the following question: is India’s current mix of domestic demand unsustainable?

If you are not able to answer these questions, and you are currently a student of macroeconomics, you might wish to add stuff outside of your textbooks into your diet.

But now, best of all, for the three paragraphs that follow the one that I quoted in the previous section, I won’t come up with a list of comments and questions. I’ll in fact ask you to come up with questions yourself, along the lines that I just did, and then see if you can answer them.

Go ahead, give it a try!

This article is a great example of what hands on macroeconomics looks like. If you are in college and are wondering what your syllabus has to do with the world outside, ask yourself a simple question: do you see yourself as being capable of writing a similar article yourself?

That, if you ask me, is a true examination. Write it, please, and share it with all of us by putting it up for us to read in the public domain. What a great addition to your CV that would be.

No?